Multifamily developers continue to churn out record levels of new supply ahead of what is expected to be a ‘peak year’ for apartment construction in 2016. The number of new apartments under construction is at its highest level since the 1980s, and double the annual historical average seen over the last 34 years.
Almost 205,000 units delivered over the four quarters ending March 31, 2016, a 2% annual increase, including 46,000 units added during the seasonally slow first quarter. With more than 240,000 units expected to deliver across the top 54 U.S. markets this year, CoStar projects 2016 to be the peak year in the current cycle for new apartment construction.
More than a half a million units are under way across the country, nearly twice the historical average since 1982.
While fewer apartment units are projected to be built next year, the construction wave isn’t expected to recede quickly. Another 220,000 units are projected to be built in 2017. If that holds, 2017 would be the fourth consecutive year that annual new supply exceeded 200,000 units, the first such period of extended building activity since Ronald Reagan was in the White House.
The large number of new units reaching completion this year and next started construction in 2015. According to U.S. Census Bureau data, quarterly construction starts of apartments have fallen over the past two quarters after peaking in third-quarter 2015 at more than 112,000 units. While starts in the first quarter were below the historical average, quarterly permit data suggests apartment-building may trend back up over the remainder of the year.
Year to date, multifamily starts have fallen 2.3% from the same period in 2015. However, the Commerce Dept. provided evidence of an uptick on Tuesday, reporting that starts of multifamily buildings with five or more units, including apartments, townhouses and condominiums, rose by 10.7% in April.
While the new construction accounts for a large number of units, it accounts for about 4.5% of U.S. apartment stock today, and is therefore considered to have a much more manageable impact today than 30 years ago, when the supply of new apartments peaked at nearly 9% of total apartment stock.
As with most real estate trends, there will be variance from market to market. For example, apartment construction is expected to have a more noticeable impact in certain markets where the new supply represents a much larger percentage of total inventory, such as Nashville and Charlotte, NC.
In Nashville, vacancies have already increased by about 150 basis points since last fall. Apartment deliveries in the booming Sunbelt city are projected to account for about 12% of the market’s total stock over the next six quarters as new projects crowd into the West End/CBD submarket.
In Charlotte, where demand has broadly matched new supply recently, developers will need to closely track fundamentals in the Uptown and South End submarkets as another 12,000 units come on line over the next few quarters, according to CoStar senior economist Ethan Vaisman, who presented the quarterly market analysis, along with Michael Cohen, CoStar director of advisory services; and real estate economist Mark Hickey.
Rents Still Moving Up
While rental rate growth likely peaked at last year’s 6% spike levels, apartment rents are still projected to increase by a strong 4% in 2016, with landlords still able to aggressively push rates in certain markets, especially in tech-concentrated areas of Portland, the San Francisco Bay Area and Seattle.
“Builders may scoff a bit at 4% rent growth after the 6% average increase we saw last year, but 4% is still really good,” said Vaisman, who added that their counterparts in office and retail sectors are quite envious of a 4% average annual rent increase.
If the average rent increase projection for the year holds, 2016 would join 2015 and 2012 as the only years since 2001 to post average rent gains of 4% or greater for the US multifamily sector.
Only two of the more than 600 U.S. submarkets with inventory of more than 5,000 units saw average apartment rents decrease over the last year. Four Seattle submarkets, Snohomish County, Bothell/Kenmore, Everett and Federal Way, are among the top 20 submarkets for annual rent growth. Five Portland submarkets in the top 20 include Hillsboro, the strongest in the nation at 12.2% rent growth, which has benefited from the opening of Intel’s new 530-acre Ronler Acres campus.
The U.S. vacancy rate edged slightly higher in the first quarter to 4.35% as the iimpact of all the new construction begins to be felt, especially at the top end of the market. However, vacancy rates remain tight by historical standards at below 5% for the 19th straight quarter in the first three month of the year, Vaisman said.
Apt. Development, Demand Spreads to Suburbs
While the development boom in CBDs and other core apartment and condominium submarkets has garnered most of the headlines, developers have actually delivered more than twice as much new multifamily supply in the suburban markets.
Several executives of large publicly traded apartment REITs spoke of a shift of development out to the suburbs during quarterly earnings conference calls with analysts over the last couple of weeks.
“We think that the suburbs might have missed some of the new supply over the last several years, but will get their fair share going forward,” said David Neithercut, president and CEO of Equity Residential Trust (NYSE: EQR).
As new apartment supply peaks amid steady job growth, market mix and price points will be important for apartment operator UDR Inc., which has a diverse portfolio spread across 20 urban and suburban markets, President and CEO Tom Toomey noted.
For example, UDR’s Seattle assets posted 8.4% revenue growth in the first quarter and “continue to benefit from the strong growth inherent in our suburban class B assets, which are located in submarkets that are less exposed to new supply,” COO Jerry Davis said.
While the suburbs may be a good spot for investors and owners in 2016 and 2017, “after that, I would suspect that they are going to start seeing the same supply pressures that we are seeing in some of the urban markets today,” Toomey added.
Like the office market, non-core, mainly suburban apartment inventory constitutes the overwhelming majority of stock at 9 million units, compared with 1.5 million core units. More than 140,000 units of non-core units were built in 2015, more than twice the 65,000 units that delivered in CBDs and other high-density, mixed-used neighborhood areas last year.
While supply expansion has driven up vacancies in suburban markets as well, with the 113,000 new units delivered last year to be joined by another 207,000 units under construction in the suburbs, vacancies should remain lower in the suburbs compared with CBD and secondary core areas, Vaisman said.
